Apex Laboratories International Inc v. City of Detroit ( 2018 )

STATE OF MICHIGAN
COURT OF APPEALS
APEX LABORATORIES INTERNATIONAL UNPUBLISHED
INC., May 17, 2018
Petitioner-Appellee,
v No. 338218
Tax Tribunal
CITY OF DETROIT, LC No. 16-000724-TT
Respondent-Appellant.
Before: SERVITTO, P.J., and RONAYNE KRAUSE and BOONSTRA, JJ.
PER CURIAM.
Respondent City of Detroit (Detroit) assessed income taxes to petitioner Apex
Laboratories International, Inc (Apex). By this action, Apex challenged Detroit’s income tax
assessment and sought a refund of income taxes paid. Detroit appeals by right the order of the
Michigan Tax Tribunal (the Tribunal) granting Apex’s motion for summary disposition and
denying Detroit’s motion for summary disposition. We affirm. 1
I. PERTINENT FACTS AND PROCEDURAL HISTORY
This case involves the liability of Apex for payment of Detroit income taxes. The parties
do not dispute the underlying material facts. A Detroit-based private equity firm, Huron Capital
Partners LLC (Huron), solicited investors to acquire partnership interests in a limited partnership,
The Huron Fund II, LP (the Fund), which in turn was to acquire shares in existing “lower
middle-market” companies. The general partner of the Fund was an entity known as Huron
Capital Partners GP II, LLC (the general partner); however, the business operations of the
general partner and the Fund were carried out by Huron.
In 2006, Huron recommended that the Fund acquire shares in (as well as debt of) Labstat
International, ULC (Labstat), a Canadian company, for eventual sale. As part of the transaction,
1
The taxes at issue were paid for the fiscal years ending in 2011 and 2013; however, because the
Tribunal adopted the convention of referring to those fiscal years as the 2010 and 2012 tax years,
we adopt that convention for consistency.
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Apex was incorporated as a Delaware corporation for the sole purpose of holding the shares of
Labstat to be acquired by the Fund—Apex never possessed or acquired any other assets.
Although Apex possessed a Detroit mailing address, it did not have any employees, owned no
real or personal property, provided no services, and sold no goods, either in Detroit or elsewhere.
Various members and employees of Huron were appointed to Apex’s board of directors. Apex
never held a board meeting.
Apex earned dividend income from its shares of Labstat in 2010, and paid those
dividends to the limited partners of the Fund. Apex paid 1% Detroit city income tax
(approximately $70,000) in 2010. In 2012, Apex sold its Labstat shares to a Canadian
corporation. According to the securities purchase agreement governing the sale, the closing was
to be conducted in the city of Waterloo, in Ontario, Canada.2 Apex realized significant capital
gains from the sale, in the amount of approximately $36 million (Canadian). Apex again paid
1% ($319,000 (U.S.)) in city income tax to Detroit in 2012.
In 2015, Apex received a proposed assessment from Detroit indicating that Detroit had
conducted an audit and had determined that Apex had miscalculated the income tax it owed for
the 2010 and 2012 tax years. Detroit assessed Apex an additional $3,280.48 in tax, interest, and
penalties for the 2010 tax year, and an additional $401,165.51 for the 2012 tax year.3 Apex
objected on the ground that it did not conduct business within the city of Detroit and lacked the
required nexus necessary for the assessment of taxes by Detroit. Apex requested a refund of the
taxes paid for the 2010 and 2012 tax years. Detroit denied the request. Apex appealed that
decision to the Tribunal in 2016.
The parties filed cross-motions for summary disposition under MCR 2.116(C)(10); the
dispositive issue was whether Apex possessed the requisite constitutional “nexus” with Detroit to
render it subject to Detroit’s taxing authority. Apex argued in the alternative that it was exempt
from city income tax as a qualifying financial institution, and that if it was liable for taxation, its
income should be subject to apportionment. Following a hearing on the parties’ motions, the
Tribunal issued a written opinion and order granting Apex’s motion, denying Detroit’s motion,
and ordering that a refund of taxes, interest, and penalties paid by Apex be issued.
The Tribunal held that Apex did not “do business” in Detroit within the meaning of the
city income tax act, MCL 141.501 et seq., because, although Apex was “doing business” under
MCL 141.605, it was not doing business in Detroit; in other words, Apex lacked the
constitutional “nexus” with Detroit to be subject to taxation. The Tribunal held that Detroit had
not established that Apex (1) had a “commercial domicile” within the city or (2) had sufficient
2
Brian Demkowicz, a managing partner of Huron and president of Apex, testified at his
deposition and averred via affidavit that the closing took place as scheduled in Canada, although
Detroit notes that emails exchanged by members of Huron and the law firm hired to assist with
the transaction appear to indicate that Demkowicz was not physically present at the closing. The
Tribunal did not explicitly find that the closing took place in a particular location.
3
Detroit’s corporate income tax rate was increased from 1% to 2% in 2012.
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“physical presence” in the city to establish such a nexus. The Tribunal also rejected Detroit’s
“unitary business group” theory on the ground that it was an “apportionment concept and not a
method to determine nexus.” The Tribunal did not address Apex’s alternative argument.4
This appeal followed.
II. STANDARD OF REVIEW
Our review of a Tribunal decision is “multifaceted.” See Briggs Tax Svc, LLC v Detroit
Public Schools, 485 Mich 69, 75; 780 NW2d 753 (2010).
If fraud is not claimed, this Court reviews the Tax Tribunal's decision for
misapplication of the law or adoption of a wrong principle. We deem the Tax
Tribunal's factual findings conclusive if they are supported by competent,
material, and substantial evidence on the whole record. But when statutory
interpretation is involved, this Court reviews the Tax Tribunal's decision de novo.
We also review de novo the grant or denial of a motion for summary disposition.
[See id. (quotation marks and footnotes omitted).]
“A Tax Tribunal decision that is not supported by competent, material, and substantial evidence
on the whole record is an error of law . . . .” Great Lakes Div of Nat’l Steel Corp v Ecorse, 227
Mich App 366, 388-389; 576 NW2d 667 (1998). “Substantial evidence must be more than a
scintilla of the evidence, although it may be substantially less than a preponderance of the
evidence.” Id. “Substantial” evidence is evidence that a reasonable mind would accept as
sufficient to support the conclusion. Kotmar, Ltd v Liquor Control Comm, 207 Mich App 687,
689; 525 NW2d 921 (1994).
We review de novo constitutional issues. See Elba Twp v Gratiot County Drain Comm’r,
493 Mich 265, 277; 831 NW2d 204 (2013).
III. ANALYSIS
Detroit argues that the Tribunal erred by determining that Apex lacked a sufficient nexus
with Detroit to be subject to city income taxation. We disagree.
The Due Process Clause of the United States Constitution5 “requires some definite link,
some minimum connection” between the state taxing authority and the person, property, or
transaction it seeks to tax. Gillette Co v Dep’t of Treasury, 198 Mich App 303, 312; 597 NW2d
595 (1993), quoting Quill Corp v North Dakota ex rel Heitkamp, 504 US 298, 306; 112 S Ct
4The Tribunal noted that Apex had already sought and received a refund of income taxes paid to
the State of Michigan for the relevant tax years.
5
US Const Am V; US Const, Am XIV. Michigan’s due process clause is generally construed no
more broadly than the federal guarantee. Const 1963, art 1, § 17; People v Sierb, 456 Mich 519,
523-524; 581 NW2d 219 (1998).
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1904; 119 L Ed 2d 91 (1992). Relevant to this appeal, a state can show that a foreign
corporation possesses sufficient “minimum contacts” for due process purposes by showing either
that the corporation had a “physical presence” within the state, or that it purposefully availed
itself of an economic market by directing its activities at the residents of the state. Quill, 504 US
at 307.
However, a tax on a foreign corporation “that withstands a due process challenge will not
necessarily withstand a Commerce Clause challenge.” Gillette, 198 Mich App at 313-314; US
Const, art I, § 8, cl 3. “A tax will sustain a Commerce Clause challenge when it: (1) is applied to
an activity with a substantial nexus with the taxing state, (2) is fairly apportioned, (3) does not
discriminate against interstate commerce, and (4) is fairly related to the services provided by the
state.” Id. A physical presence within the state is required to find such a substantial nexus,
although this requirement may be satisfied by the presence in the state of “property or the
conduct of economic activities in the taxing State performed by the [corporation’s] personnel or
on its behalf.” Magnetek Controls, Inc v Dep’t of Treasury, 221 Mich App 400, 411; 562 NW2d
219 (1997) (quotation marks and citation omitted).
Detroit imposes an income tax on its residents under an ordinance that incorporates the
city income tax act, MCL 141.501 et seq. The act permits cities to impose an income tax on
residents and non-residents doing business in the city by incorporating a uniform city income tax
ordinance. See MCL 141.503(1). The act also provides that the city may enter into an
agreement with the Department of Treasury under which the Department will administer,
enforce, and collect the city income tax. See MCL 141.509(1). The parties do not dispute the
Tribunal’s application of constitutional standards to this state-authorized income tax, despite the
fact that Detroit is not itself a state agency.
The parties and the Tribunal did not specifically address the application of the Due
Process or Commerce Clauses to Detroit’s assessment of income tax to Apex; nonetheless, the
majority of the parties’ arguments, and the Tribunal’s decision, centered on whether Apex had a
“nexus” with Detroit such that the assessment of income tax against it was constitutionally valid.
However, the Tribunal, before setting forth its constitutional analysis, noted that the city income
tax act authorized Detroit to collect income tax on “the taxable net profits of a corporation doing
business in the city, being levied on such part of the taxable net profits as is earned by the
corporation as a result of work done, services rendered and other business activities conducted in
the city, as determined in accordance with this ordinance.” MCL 141.614. The Tribunal further
noted that the act defines “doing business” as “the conduct of any activity with the object of gain
or benefit” except for certain activities related to the solicitation of orders for the sale of tangible
property or the storage of personal property. MCL 141.605. The Tribunal concluded that
although Apex was “doing business” within the meaning of MCL 141.605, it was not “doing
business in the city” under MCL 141.614.
The Tribunal’s conclusion was not based on the “misapplication of the law or adoption of
a wrong principle” and was supported by “competent, material, and substantial evidence.”
Briggs Tax Svc, 485 Mich at 75. The Tribunal held that Apex’s “activity” in acquiring and
holding Labstat’s stock satisfied the “any activity” standard and that it was “conducted with the
objective of gain or benefit,” noting that affidavits from employees of Huron indicated that the
acquisition and sale of Labstat shares was an investment opportunity, that Apex was created to
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maximize that investment, that Apex received dividends by virtue of its holding of Labstat
shares, and that Apex ultimately sold Labstat shares at a profit.
The Tribunal then held that Apex was not doing business “in the city of Detroit.” The
Tribunal first rejected Detroit’s argument that Apex’s “commercial domicile” was relevant to
this conclusion. The term “commercial domicile” is found in the income tax act of 1967,
MCL 206.1 et seq., and is defined as a corporation’s “principal place from which the trade or
business of the taxpayer is directed or managed.” MCL 206.6(1). We agree with the Tribunal
that the application of this concept, which does not appear in the city income tax act, is
unnecessary to the determination of whether Apex was “doing business in the city” of Detroit;
the plain language of MCL 141.614 contemplates the assessment of income tax (apportioned, if
necessary) on a corporation that is doing any business in the city; the city need not be the
“principal place from which the trade or business” of the corporation is directed or managed,
MCL 206.6(1).
After dismissing the “commercial domicile” argument, the Tribunal then employed the
constitutional analysis discussed in Quill, 504 US at 306-317, ultimately concluding that the
record did not demonstrate that Apex had either a physical presence in or substantial connection
with Detroit. This approach was not based on an error of law; in order to satisfy the statutory
requirement of doing business “in the city,” Apex would have had to at least meet the minimum
constitutional standards under the Due Process Clause and Commerce Clause. See Caterpillar,
Inc v Dep’t of Treasury, 440 Mich App 400 at 413; 488 NW2d 182 (1992) (applying
constitutional standards in determining if a “substantial nexus” existed between the respondent
and Michigan under the Single Business Tax Act, which provided for taxation of a corporation’s
“business activity” in Michigan).
The Tribunal concluded that Apex lacked a “physical presence” in Detroit, noting that,
although the city income tax act does not define “physical presence,” the income tax act of 1967
defines physical presence as
any activity conducted by the taxpayer or on behalf of the taxpayer by the
taxpayer's employee, agent, or independent contractor acting in a representative
capacity. Physical presence does not include the activities of professionals
providing services in a professional capacity or other service providers if the
activity is not significantly associated with the taxpayer's ability to establish and
maintain a market in this state. [MCL 206.621(2)(b).]
The Tribunal rejected Detroit’s argument that, although Apex had no employees, the activities of
Apex’s officers and directors were conducted on Apex’s behalf for its benefit, finding that the
evidence showed that Apex’s officers and directors acted on behalf of Huron or Labstat, not
Apex. That conclusion is supported by the substantial, competent, and material evidence.
Briggs Tax Svc, 485 Mich at 75. Various officers and directors of Apex, through deposition
testimony and affidavits, attested that they were employed by Huron and worked for the benefit
of Huron. Essentially, these officers and directors worked to increase the value of Labstat and
negotiate the sale of Labstat shares for the benefit of Huron; these activities were not conducted
“on behalf” of Apex any more than a business transaction is conducted “on behalf” of the bank
account into which the proceeds will be deposited. Moreover, the Tribunal noted that to the
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extent Apex employed professional consultants, this fell under the exclusion found in
MCL 206.621(2)(b). We agree, as the record shows that the use of professional consultants,
such as law firms and marketing consultants, was done to facilitate the sale of a Canadian
company to a Canadian purchaser in order to benefit the Fund’s investors, not to establish or
maintain a market in Detroit. Additionally, the Tribunal noted the uncontested fact that Apex
was not engaged in the sale of any goods or services in Detroit (or indeed, anywhere), and
declined to find that a physical presence or substantial nexus existed between Apex and Detroit
based on the use of a Detroit mailing address.6
On appeal, Detroit does not challenge the Tribunal’s reference to MCL 206.621 in
defining “physical presence,” but rather invites this Court to hold that the Tribunal erred in its
factual findings. We decline to do so, as those findings were supported by “more than a
scintilla” of evidence, Great Lakes Div of Nat’l Steel Corp, 227 Mich App at 388-389, and a
reasonable mind would accept that evidence as sufficient to support the conclusion. Kotmar, 207
Mich App at 689. The lack of physical presence, under Quill, renders Detroit’s assessment of
income tax against Apex violative of the Commerce Clause; Detroit therefore cannot satisfy
MCL 141.614’s requirement that the entity being assessed tax be doing business “in the city.”7
The Tribunal properly granted summary disposition in favor of Apex under MCR 2.116(C)(10).
Affirmed.
/s/ Deborah A. Servitto
/s/ Amy Ronayne Krause
/s/ Mark T. Boonstra
6
The record indicates that mail received at that address was generally marked “Care of Huron
Capital Partners, LLC.”
7
On appeal, Detroit does not assert the “unitary business” theory it argued below; we do not
disturb the Tribunal’s conclusion regarding that theory.
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